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March 28, 2024

Modern and Fair: Expanding the Sales Tax to Reflect the “New Economy”

In order to have a budget that makes critical investments in community needs, like public education, health care, and housing, we need to create new and sustainable revenue streams. At the same time, lawmakers need to update our tax code to reflect our modern economy. The expansion of the sales tax base to include “new economy” products in the 2024 budget passed by bipartisan majorities in the General Assembly does both. It raises over $1 billion in new General Fund revenues — the funds that lawmakers have the most control over — while also updating the sales tax to reflect modern consumer habits. The budget is now with the governor to accept, amend, or reject, but we urge the governor to approve the expanded sales tax as passed by the General Assembly.

What is the “new economy” sales tax?

Every budget proposal during the 2024 legislative session, starting with the governor’s introduced tax package, included a proposal to expand the sales tax base to new economy products. This proposal would add definitions of “digital personal property” and  “taxable services” to the state’s tax code. “Taxable services” would include software application services, computer-related services, website hosting and design, data storage; and streaming services. Under the governor’s proposal, people in Virginia would pay tax on these new economy products, but businesses and corporations would have been exempt. (This presentation on the governor’s tax proposal from Secretary of Finance Stephen Cummings outlines examples of “new economy” products that would be included in the sales tax base expansion.) 

When it was time to craft their own proposals, while each chamber rejected other components of the governor’s original proposal that would have given substantial benefits to the highest income households in the state while asking more of those with the lowest incomes, each chamber kept or built upon the proposed new economy sales tax expansion. The House kept the governor’s original proposal, while the Senate captured additional revenues by removing the proposed exemption for business-to-business (B2B) transactions. The final budget passed by the legislature maintained the B2B digital sales tax only for when businesses are the consumers of software application services, drawing down critical resources for state investments and taking a step toward tax fairness.

These reforms are sensible. Our economy has shifted consumer habits to a realm unforeseen when Virginia’s sales tax was first implemented: we might subscribe to software rather than own it, we use cloud storage instead of physical hard drives, we stream music and movies rather than purchase CDs and DVDs of the newest release. With this shift, Virginia loses millions in resources every year that could go toward the building blocks of our communities. Our tax code should be updated to reflect our modern existence.

A long called for reform

This is far from the first time similar proposals have been debated in Virginia or elsewhere, and TCI has long supported this modernization. While they vary in scope and size (think, different “baskets” of goods and services), 39 states in addition to Alaska municipalities and D.C. extend their sales tax to some digital products. This makes Virginia one of the seven remaining states with a sales tax that includes no digital products in its sales tax base.

Additionally, when it comes to their specific “baskets” of new economy goods and services, few states make any exceptions for cases where businesses are the purchaser. As proposed in the legislature-passed budget, Virginia would become one of five states that give businesses special treatment when taxing digital products. As of 2022, only Iowa offers a broad exemption, while Maryland, New Jersey, and Washington allow partial exemptions. Connecticut has a reduced rate for B2B transactions.

How it benefits all of us

This expansion means updated revenues to reflect an updated tax code. By including the governor’s proposed extension of the sales tax to digital goods and services for individuals and the additional extension to B2B software services, the budget passed by the General Assembly would bring in $1.05 billion more for the General Fund, which helps fund higher levels of investment in Virginia’s schools. Overall, legislators provide $1.2 billion more in General Funds to Direct Aid for Public Education than the governor’s introduced budget after adjusting for the movement of certain programs into Direct Aid (without this adjustment, the increase would be greater).

Addressing the impact of Virginia’s upside-down tax code

While this proposed reform moves our tax code to greater fairness by reflecting how consumers are actually spending their money, as well as making sure that businesses are paying their fair share and are not always exempt from the proposed change, sales taxes in general ask more of those with less. Families with lower incomes tend to spend higher proportions of their incomes on essentials like food and clothing, and therefore more in sales taxes. 

While lawmakers consider options to modernize our tax code, they should also consider ways to provide families with meaningful economic support. Improving the state’s refundable Earned Income Tax Credit (EITC) and establishing a Commonwealth Kids Credit would help low and middle-income families receive more cash back at tax time. For a single mother of two making the average salary of a home health aide in Virginia, these changes would have meant $1,271 more in cash back when filing her taxes this year.

The modernization of our sales tax base for individuals and B2B transactions would lead to key and long-overdue investments in our communities. Lawmakers also have further opportunities to raise critical revenues and invest in the tools that will help our communities thrive. For example, a Fair Share Tax, which would establish a new 10% tax rate on annual taxable income over $1 million, would have raised $3 billion in additional revenues this budget cycle. Proposals to enact these tax policy changes were considered during the 2024 legislative session but were not ultimately successful. Lawmakers should continue to consider these measures as discussions about the Virginia tax code continue this offseason and beyond.

Megan Davis

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